Chapter 22: Q3CE (page 1325)
What reporting requirements does retrospective application require?
The retrospective application requires three major things.
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Botticelli Inc. was organized in late 2015 to manufacture and sell hosiery. At the end of its fourth year of operation, the company has been fairly successful, as indicated by the following reported net incomes.
2015 \(140,000a 2017 \)205,000
2016 160,000b 2018 276,000
a Includes a \(10,000 increase because of change in bad debt experience rate.
bIncludes a gain of \)30,000.
The company has decided to expand operations and has applied for a sizable bank loan. The bank officer has indicated that the records should be audited and presented in comparative statements to facilitate analysis by the bank. Botticelli Inc. therefore hired the auditing firm of Check & Doublecheck Co. and has provided the following additional information.
1. In early 2016, Botticelli Inc. changed its estimate from 2% of sales to 1% on the amount of bad debt expense to be charged to operations. Bad debt expense for 2015, if a 1% rate had been used, would have been \(10,000. The company therefore restated its net income for 2015.
2. In 2018, the auditor discovered that the company had changed its method of inventory pricing from LIFO to FIFO. The effect on the income statements for the previous years is as follows.
2015 2016 2017 2018
Net income unadjusted—LIFO basis \)140,000 \(160,000 \)205,000 \(276,000
Net income unadjusted—FIFO basis 155,000 165,000 215,000 260,000
\) 15,000 \( 5,000 \) 10,000 \( (16,000)
3. In 2018, the auditor discovered that:
(a) The company incorrectly overstated the ending inventory (under both LIFO and FIFO) by \)14,000 in 2017.
(b) A dispute developed in 2016 with the Internal Revenue Service over the deductibility of entertainment expenses. In 2015, the company was not permitted these deductions, but a tax settlement was reached in 2018 that allowed these expenses. As a result of the court’s finding, tax expenses in 2018 were reduced by $60,000.
Instructions
(a) Indicate how each of these changes or corrections should be handled in the accounting records. (Ignore income tax considerations.)
(b) Present net income as reported in comparative income statements for the years 2015 to 2018
An entry to record Purchases and related Accounts Payable of $13,000 for merchandise purchased on December 23, 2018, was recorded in January 2019. This merchandise was not included in inventory at December 31, 2018. What effect does this error have on reported net income for 2018? What entry should be made to correct for this error, assuming that the books are not closed for 2018?
Taveras Co. decides at the beginning of 2017 to adopt the FIFO method of inventory valuation. Taveras had used the LIFO method for financial reporting since its inception on January 1, 2015, and had maintained records adequate to apply the FIFO method retrospectively. Taveras concluded that FIFO is the preferable inventory method because it reflects the current cost of inventory on the balance sheet. The following table presents the effects of the change in accounting principles on inventory and cost of goods sold. Inventory Determined by Cost of Goods Sold Determined by Date LIFO Method FIFO Method LIFO Method FIFO Method January 1, 2015 \( 0 \) 0 \( 0 \) 0 December 31, 2015 100 80 800 820 December 31, 2016 200 240 1,000 940 December 31, 2017 320 390 1,130 1,100 Other information: 1. For each year presented, sales are \(3,000 and operating expenses are \)1,000. 2. Taveras provides two years of financial statements. Earnings per share information is not required. Instructions (a) Prepare income statements under LIFO and FIFO for 2015, 2016, and 2017. (b) Prepare income statements reflecting the retrospective application of the accounting change from the LIFO method to the FIFO method for 2017 and 2016. (c) Prepare the note to the financial statements describing the change in method of inventory valuation. In the note, indicate the income statement line items for 2017 and 2016 that were affected by the change in accounting principle. (d) Prepare comparative retained earnings statements for 2016 and 2017 under FIFO. Retained earnings reported under LIFO are as follows: Retained Earnings Balance December 31, 2015 $1,200 December 31, 2016 2,200 December 31, 2017 3,070
You have been asked by a client to review the records of Roberts Company, a small manufacturer of precision tools and machines. Your client is interested in buying the business, and arrangements have been made for you to review the accounting records. Your examination reveals the following information.
1. Roberts Company commenced business on April 1, 2015, and has been reporting on a fiscal year ending March 31. The company has never been audited, but the annual statements prepared by the bookkeeper reflect the following income before closing and before deducting income taxes.
Year Ended March 31 Income Before Taxes
2016 \( 71,600
2017 111,400
2018 103,580
2. A relatively small number of machines have been shipped on consignment. These transactions have been recorded as ordinary sales and billed as such. On March 31 of each year, machines billed and in the hands of consignees amounted to:
2016 \)6,500
2017 none
2018 5,590
Sales price was determined by adding 25% to cost. Assume that the consigned machines are sold the following year.
3. On March 30, 2017, two machines were shipped to a customer on a C.O.D. basis. The sale was not entered until April 5, 2017, when cash was received for \(6,100. The machines were not included in the inventory at March 31, 2017. (Title passed on March 30, 2017.)
4. All machines are sold subject to a 5-year warranty. It is estimated that the expense ultimately to be incurred in connection with the warranty will amount to ½ of 1% of sales. The company has charged an expense account for warranty costs incurred. Sales per books and warranty costs were as follows.
Year Ended March 31 Sales Warranty Expense for Sales Made in
2016 2017 2018 Total
2016 \) 940,000 \(760 \) 760
2017 1,010,000 360 \(1,310 1,670
2018 1,795,000 320 1,620 \)1,910 3,850
Bad Debts Incurred on Sales Made in Bad Debt Expense 2016 2017 2018 Total Based on 1% of Receivables 2016 \(750 \) 750 \(2,334 2017 800 \) 520 1,320 2,557 2018 350 1,800 \(1,700 3,850 4,458
5. Bad debts have been recorded on a direct write-off basis. Experience of similar enterprises indicates that losses will approximate 1% of receivables. Bad debts written off were:
6. The bank deducts 6% on all contracts financed. Of this amount, ½% is placed in a reserve to the credit of Roberts Company that is refunded to Roberts as finance contracts are paid in full. (Thus, Roberts should have a receivable for these payments and should record revenue when the net balance is remitted each year.) The reserve established by the bank has not been reflected in the books of Roberts. The excess of credits over debits (net increase) to the reserve account with Roberts on the books of the bank for each fiscal year were as follows. 2016 \) 3,000 2017 3,900 2018 5,100 \(12,000
7. Commissions on sales have been entered when paid. Commissions payable on March 31 of each year were as follows. 2016 \)1,400 2017 900 2018 1,120
8. A review of the corporate minutes reveals the manager is entitled to a bonus of 1% of the income before deducting income taxes and the bonus. The bonuses have never been recorded or paid.
Instructions
(a) Present a schedule showing the revised income before income taxes for each of the years ended March 31, 2016, 2017, and 2018. (Make computations to the nearest whole dollar.)
(b) Prepare the journal entry or entries you would give the bookkeeper to correct the books. Assume the books have not yet been closed for the fiscal year ended March 31, 2018. Disregard correction of income taxes.
Access the glossary (“Master Glossary”) to answer the following.
(a) What is a change in accounting estimate?
(b) What is a change in accounting principle?
(c) What is a restatement?
(d) What is the definition of “retrospective application”?
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